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5 Things to know about RBI’s push for bankruptcy code
The business news headlines on 14th June 2017 read something like this: 12 accounts constitute 25% of overall bad loans. It made everybody sit up and take notice. To think that only 12 loan accounts owed more than Rs 5,000 crore each!
The rest of the news report is equally important—not just the key numbers. The RBI said that it would push these 12 accounts to start bankruptcy proceedings. This is even more notable.
Let’s read why you should follow this issue:
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Why is this important?India’s banks have bad loans worth Rs 7.7 lakh crore, as per various media reports. This problem of bad loans has been going on for years. It has only put more and more pressure on banks and their profitability. This makes the whole banking system risky. With RBI identifying the large troubled accounts and pushing them towards bankruptcy could lead to a speedy resolution. This has been widely acknowledged as a ‘bold’ move. Moreover, the RBI has also asked banks to finalise solutions for other bad loans in the next six months. Otherwise, the banks would have to start bankruptcy proceedings against these loan accounts too. This is the latest in the series of actions taken by the RBI to tackle bad loans. Perhaps this is why banking stocks are up over 27% since January 2017, while the Sensex rose just 16.7%.
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What will happen to the 12 accounts? The lender has to start a bankruptcy proceeding. The company or individual who borrowed the money will then be referred to the National Company Law Tribunal (NCLT). They will be judged as per the Insolvency and Bankruptcy Code (IBC). This law allows debt-laden companies and even individuals to reorganise their debt. The key aspect of the law is that this whole process takes place within a 180-day window. Of course, this can be extended by another 90 days. But 270 days still a shorter time period.
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What is the bankruptcy process? During the six-month period, the NCLT appoints an ‘Insolvency Professional’. This individual takes over the company’s control and runs it. The Insolvency Professional aims to try and turn the company around. She/he may try to restructure the business plan. This has to be approved by the lenders. If the professional is unable to come up with a good plan within the time window, the lenders will then start selling the company’s assets to raise money. This is called company liquidation or insolvency. This can only happen after the 270-day window is over.[Source]
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The challenges: The process will not be easy. For starters, the law is fairly new—it was enacted in 2016. The bankruptcy and insolvency process has not been tested yet. A Kotak Institutional Equities report suggested that so far, no case has been resolved. “Experts we spoke to suggest a two-year window for the law to be fully functional. Referring large cases at such an early stage is a risky approach,” the Kotak report said. That said, if the process works, it could be a game changer, the report added. Another challenge is that there may not be enough experienced professionals to solve such cases. This could mean extra delays or worse, improper solutions.
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What it means for banks: Starting bankruptcy proceedings is not a common move. Banks would need detailed guidelines from the RBI about the whole process. But the biggest risk is about potential losses to banks. When you sell assets of a company, you get the current market rate. However, industries like power and steel are not in the best state. So, market rates could be much lower today. This means banks may be able to recover a significant portion of the loan. This is called a haircut. High haircuts can put stress on a bank’s profitability.( Read more: 5 ways to tackle India’s debt problem)
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25,000
A report by consulting firm Alvarez & Marsal suggested that the NCLT already has 25,000 pending cases. Moreover, with the current staff strength, the NCLT could take over 7 years to clear these cases, according to the Livemint report dating January 2017. So, an addition of cases could cause an extra backlog. However, news reports suggest that the 12 accounts would be pushed to the top of the priority list.
